Question

In a factory, actual fixed cost overheads were different from the standard fixed overheads because the actual output, actual time consumed, actual rate per hour and per unit of output differed. Compute the variances taking assumed figures.

Answer 1

Objective testing questions involving the under or over absorption of overhead and fixed overhead volume variances commonly cause difficulties for F2/FMA candidates. This article looks at a graphical explanation of fixed overhead absorption

UNDER OR OVER ABSORPTION

Consider a company with budgeted fixed production overheads of $10,000 for the coming year. Graph 1 represents the behaviour of this cost with respect to volume of output.



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If budgeted output (activity) for the year was 1,000 units, the company could use a fixed production overhead absorption rate (FOAR) of:

Budgeted fixed production overhead    =      $10,000    =    $10 per unit
              Budgeted units                               1,000

 

Graph 2 shows this FOAR being used to absorb overhead into production, in a situation where output and expenditure are as budgeted.



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The graph shows that absorption costing takes what is a fixed cost ($10,000 per year), and converts it to a cost per unit of activity, effectively treating it as a variable cost ($10 per unit).

This approach will lead to the correct amount of overhead being absorbed, if

Actual activity = budgeted activity, andActual overhead = budgeted overhead.

However if either of these conditions are broken then under or over absorption of overhead can occur.

Graph 3 shows a situation where actual activity is greater than budgeted activity and actual overhead expenditure is as budgeted. This results in $12,000 of overhead being absorbed and consequent over absorption of overhead by $2,000.

Absorbed overhead = Actual units x FOAR = 1,200 units
x $10 per unit =$12,000 Actual overhead = $10,000 Over/(under)absorbed overhead$2,000 



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Graph 4 shows a situation where both actual activity and actual overhead expenditure differ from budget.

In this case actual activity is greater than budgeted, leading to over absorption. At the same time actual overhead is lower than budgeted, also leading to over absorption. The total over absorption is $5,000.

Absorbed overhead = Actual units x FOAR = 1,200 units x
$10 per unit = $12,000 Actual overhead = $7,000 Over/(under)absorbed overhead$5,000 

The graph shows that of the $5,000 over absorption, $2,000 is due to increased activity ($12,000 absorbed being greater than $10,000 budgeted) and $3,000 being due to reduced expenditure (actual expenditure being $7,000 as compared to $10,000 budgeted.



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